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If you risk too much, you can lose too much.
By Tom Long | October 23, 2007
We often talk about the money management aspect of a trade. Naturally, we recommend using a 1:2 risk:reward ratio, which means to look for two pips of profit for every pip risked on a trade. But often the question of how big of a position to open and how many different trades one should have open at once will come up. It is an important part of trading and money management. I always recommend risking no more than 5% of your account balance at any one time. That includes all open positions. If you have 10 different trades open at once, each risking 5% of your account balance, then you are really risking 50% of your money at one time. That is too much and opens you up to a possible large loss if the market turns. Buying the GBP/USD and then buying the EUR/USD is really not that different. The GBP and the EUR will react to different events and one can be stronger than the other, but you are basically still selling the USD. So to keep your risk manageable, I recommend opening one trade at a time. If you have a $10,000 account balance, you can risk 5% or $500 on your next trade. If you want to buy the EUR/USD and are risking 100 pips, that is a risk of $100 per mini lot. So you can open five mini lots for a total risk of $500. If you are risking 100 pips, you should look for at least 200 pips in profit to maintain your 1:2 risk:reward ratio. What I like to do is to move my protective stop up to the breakeven level once the market moves halfway to my target. So if you buy the EUR/USD at 1.4000 and place your stop at 1.3900 and your limit to take profits at 1.4200, I recommend moving your stop up to your entry level of 1.4000 as the market trades up to the 1.4100 level. At this point, you theoretically have no risk in the trade as one of two things can happen….you can win the 200 pips or break even. That means you can now use that 5% risk and open a second trade. If the trends are strong and you continue to move your stop to breakeven as the market moves halfway to your limit price, you can have multiple positions open at once. But no more than one trade can be a losing trade as the others should have their protective stops at the breakeven level. This way we trade more when we are winning and less when we are losing, which is key to long-term success.
noneTopics: Don't Trade Like This |